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Weekly Update: The most beautiful wall of worry has May flowers on it

As of 05-03-2013

I spent part of this week in sunny San Diego—I know we’re having a great stretch of weather in Pittsburgh but day in and day out, is there any place in the lower 48 that can beat San Diego? Several people there, and in very hot Phoenix earlier in the week (it was above 100 degrees!) tried to get me to agree with them that we have this to worry about and that to worry about. But I told them you can’t fight the Fed (it’s hard not to consider this week’s post-meeting statement, in which it said it could either reduce or increase quantitative-easing purchases, as dovish), the ECB (it cut its benchmark rate to a record low this week) or all the other central banks out there. If all that liquidity weren’t enough, austerity has come under attack. Congress already is acting to pull back on some sequester cuts, including furloughs that created air traffic delays. In Europe, the leader of the new Italian government says he is opposed to austerity, a sentiment shared by leaders of Spain and France, where they are backing off promises to lower their governments’ debt-to-GDP ratios that exceed 90%. They must certainly be much less concerned now that a spreadsheet error has raised questions about the Reinhart/Rogoff thesis that debt-to-GDP ratios above this level inevitably depress economic growth. The hostile reaction to austerity, along with the collapse of its academic credentials, suggests anti-austerity politicians and centrals bankers will continue to run the show.

The S&P 500 and the Dow at this writing are at record highs, having broken through their respective 1,600 and 15,000 levels. Pity the bears I have met in San Diego, Phoenix and all over the country. They keep waiting for that big pullback to get in, and it has yet to come.  JP Morgan says the majority of people still seem bearish and each dip (such as the one on Wednesday) continues to generate a lot of “this is it” talk (i.e., the start of a “big” correction of more than 7%). May generally does mark the start of a seasonally weak period (hence the “Sell in May and go away’’ axiom), with average S&P gains of 0.4% from May through September, according to Deutsche Bank. Strong January through April runs, such as this year’s 12% gain in the S&P, tend to negate some of this seasonal weakness, although brief 5% pullbacks are common. But this market is still being led by defensive sectors, which tend to outperform cyclicals during the summer months. The Institutional Strategist says that, technically, the S&P is poised to head for 1,750-1,900 (!), with the other possibility a correction lasting eight to nine weeks that could take 7% to 15% off the averages. Equities are being driven by central bank profligacy from Tokyo to New York and, if anything, the world may be lining up for another round of alternative QE, including purchases of corporate bonds and equities. With bond yields so low, almost half of the 60 central bankers recently surveyed by Bloomberg said they are taking on more risk. Fourteen said they had already invested in equities or would do so within five years. A Wall Street Journal story this week also noted the number of bond funds that own stocks is at an 18-year high.

If all roads lead to jobs (more below), what is the next catalyst for this market? Dudack Research says the S&P appears to be at a crossroads. A rally to new cyclical highs needs to be accompanied by a solid overbought reading to demonstrate consistent buying pressure. Overall, the lack of volume on this rally reflects a lack of conviction. More than halfway through the reporting season, we’re seeing record earnings that have surprised marginally to the upside and revenues that have marginally disappointed. Profit margins have shrunk 61 basis points from third-quarter 2011’s high, raising the question of whether the profit cycle has peaked. The declines in sales growth, earnings growth and mar­gins are actually less than average after historical peaks, suggesting margins could be plateauing as they did in the mid-1990s, according to Ned David Research. What we really have to watch for is sales, and we won’t know much about that until the next quarter. The wall of worry always has something to worry about, and that is what it’s going to be.


All roads lead to jobs April payrolls surprised to the upside, growing 165,000 with 114,000 in upward revisions in the prior two months. The unemployment rate also unexpectedly fell to 7.5% for the right reasons—household gains outpaced growth in the labor force—adding to the view that there is a significant chance the rate will hit the Fed’s target 6.5% sometime in the middle of 2014 (though the Fed has hinted it may let the rate fall further before acting). It wasn’t all good news. The workweek was shorter and there was slight increase in the broader U6 measure of labor underutilization due to an increase in part-time workers for economic reasons. But combined with this week’s unexpected plunge in new jobless claims, Friday’s jobs report provided something of an antidote to the spring swoon story for 2013 and a catalyst for today’s market rally.

Housing recovery strengthens Home prices, arguably the key gauge of housing’s health, are accelerating. February's Case-Shiller index rose more than expected and is up 9.3% year-over-year led by red-hot Phoenix (I can attest to that!), benefitting from greater demand and low inventory that is holding back sales. Despite some softness in new-home sales, attributable somewhat to unseasonably cold weather and the aforementioned shortage of homes, the leading pending home sales index has been grinding higher in line with trends in existing home sales and reports from the builders on prospective buyer traffic. The seasonally adjusted index is 7% ahead of year-ago levels and, ignoring the period when government stimulus was a temporary boost, is at its highest level in six years.

Consumer mood improving The Conference Board gauge popped to 68.1 from 61.9 in March, well above flat forecasts. Expectations drove the increase, aided by equity market gains and rising home prices. Notably, respondents were more bullish on equities than they have been at any time in the last five years, a sign the market’s momentum may moderate over the next few months. March consumer spending also reflected consumer resiliency in the face of higher taxes and sequestration worries. It rose a better-than-expected 0.3% on an inflation-adjusted basis, matching February’s increase and slightly higher than January’s 0.2% uptick. Consumers did, however, pull back on auto purchases, which slipped below the 15 million annualized rate to their lowest level since last October.


March construction spending misses badly It fell 1.7% versus expectations for 0.6% rise. The drop-off was concentrated in nonresidential spending, however, as residential spending grew modestly. The largest decline occurred in public highway and street spending—public construction spending has been trending down since 2009 and was impacted by sequestration-related cuts. Crummy weather in March and early April also played a role. Even with the weaker-than-expected March, first-quarter construction spending was about $4.5 billion—enough to add about a tenth of a point to the initially reported 2.5% increase.

Manufacturing slowdown April’s ISM slipped to 50.7, not as bad as forecast, while the forward-looking new orders component and production rose strongly. Inventories continued to decline, suggesting slower manufacturing inventory accumulation in this quarter, but overall, the report’s components were slightly more favorable than the modest headline decline would suggest. While consistent with lower GDP growth in Q2 relative to Q1—and while both Dallas and Chicago manufacturing gauges suggested regional contraction and March factory orders fell more than expected—April’s modest ISM gains may signify a bottoming following broad-based deterioration in earlier spring data. The separate and final Markit monthly gauge inched up from its initial reading on the month, while April’s ISM services gauge was modestly disappointing though still solidly entrenched in expansion territory.

Deflation talk returns While much of the focus on the Fed’s commitment to “QE to infinity” has been on jobs and unemployment, the other key metric—inflation— also is offering support. The core consumption price deflator (ex-food & energy) was up a stunningly low 1.1% year-over-year, and overall PCE prices were up just 1% in March year-over-year, down from 1.3% in February. It’s somewhat strange how quickly the market can shift from worrying about inflation to worrying (again) about deflation—“deflation” is on the rise in Google trends. This actually could be a positive for the markets. If we don’t get deflation, equities could adjust higher quickly given the fear.

What else

Someone please tell my daughter The average starting salary for accounting graduates for 2013 is $53,300, up 7% from a year ago, according to the National Association of Colleges and Employers. For college graduates in general, the overall average starting salary this year is $44,928, up 5.3%. Engineering, it seems, is particularly lucrative—engineering majors have captured eight of the top 10 majors’ starting salaries.

Pride over pizza There is a shortage of pizza-makers in Italy, the country generally considered to be pizza’s home. This is because long hours and modest pay have many Italians shunning the job despite a long recession and high unemployment.

Sometimes my husband is so unreasonable! Financial pressures are causing Americans more stress; nearly half of respondents report they are sleeping less because of such concerns, according to an American Institute of Certified Public Accountants survey. Other ways this stress is manifesting itself include eating more junk food, spending less time with friends and arguing with spouses.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
Dow Jones Industrial Average ("DJIA"): An unmanaged index which represents share prices of selected blue chip industrial corporations as well as public utility and transportation companies. The DJIA indicates daily changes in the average price of stocks in any of its categories. It also reports total sales for each group of industries. Because it represents the top corporations of America, the DJIA's index movements are leading economic indicators for the stock market as a whole. Indexes are unmanaged and investments cannot be made in an index.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
Personal Consumption Expenditure (PCE) Index: A measure of inflation at the consumer level.
S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.
The Chicago Purchasing Managers Index, produced by the The National Association of Purchasing Management–Chicago, gauges factory health in the upper Midwest based on surveys of companies in that region.
The Consumer Confidence Index is based on a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.
The Federal Reserve Bank of Dallas' monthly Texas Manufacturing Outlook Survey is a measure of the current level of activity and expectations for the future.
The Institute of Supply Management (ISM) manufacturing index is a composite, forward-looking derived from a monthly survey of U.S. businesses.
The Institute of Supply Management (ISM) nonmanufacturing index is a composite, forward-looking index derived from a monthly survey of U.S. businesses.
The Markit U.S. Manufacturing Purchasing Managers’ Index (PMI) is a gauge of manufacturing activity in the United States.
The pending home sales index, released monthly by the National Association of Realtors, is designed to be a leading indicator of housing activity.
The S&P/Case-Shiller Home Price Indices measure track changes in the value of the residential real estate market in major metropolitan regions.
Federated Equity Management Co. of Pennsylvania
Copyright © 2014 Federated Investors, Inc.

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